Rev. Rul. 75-405

Advice has been requested concerning the Federal income tax treatment of the costs of raising pistachio seedlings from seed through the first budding of the trees in the field.

A taxpayer is engaged in the business of producing and selling pistachio nuts. The taxpayer develops and grows seedlings by planting purchased seeds in small pots, usually four to a pot. Once the seeds have successfully sprouted and sufficient time has elapsed to permit transplantation, each of the sprouted seeds is transferred to an individual larger pot. The transplanted sprouts are then allowed to mature in the larger pots for up to one year or until they attain a minimum girth of approximately 3/8 of an inch.

When the seedlings have attained sufficient girth, and other factors are favorable, they are once again transplanted; this time to their permanent orchard location. After sufficient time has elapsed to overcome the shock of that transplantation, each seedling is individually "budded" by grafting onto the seedling a small portion of a producing tree. Commercial variety pistachios must be obtained from budded trees since the root stock by itself cannot produce a marketable product.

Section 162(a) of the Internal Revenue Code of 1954 provides, in part, that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 263(a) of the Code provides generally that no deduction shall be allowed for capital expenditures. A capital expenditure is one that creates, or results in the permanent improvement or betterment of, an asset that has a useful life greater than one year. See sections 1.263(a)-1 and 1.461-1(a)(1) and (2) of the Income Tax Regulations.

Although the cost of seeds and the cost of planting seeds would be currently deductible expenses under section 162(a) of the Code if they were expenses incurred in raising yearly crops, such costs must be capitalized if they are incurred in connection with the development of trees that will have a value lasting a number of years.

In Ashworth v. United States, 71-2 U.S.T.C. 9710 (D. 111. 1971), the court stated that the costs of an orange tree that must be capitalized include the cost of raising a seedling to the point when it can be transplanted to an orchard. Only at that point is the tree commercially recognized as a viable orange tree. When costs incurred in order to begin growing oranges are contrasted with costs incurred in order to begin growing orange trees, it is clear that all costs of developing a seedling into a transplantable orange tree are preparatory expenditures to begin growing oranges and must be capitalized.

In the instant case, all costs incurred by the taxpayer in raising pistachio seedlings up through the budding stage are preparatory expenditures in that such costs are necessary to begin growing pistachios. Accordingly, all costs of raising pistachio seedlings from seed through the first budding of the trees in the field are capital expenditures and are not deductible business expenses.

The Service will not follow the cases of Robert L. Maple, 27 CCH Tax Ct. Mem. 944 (1968), aff'd, 440 F. 2d 1055 (9th Cir. 1971), and Wagner Mills, Inc., 33 CCH Tax Ct. Mem. 1267 (1974), which held that the costs of care and preparation of citrus seedlings prior to permanent planting were deductible under section 162(a) of the Code.